Three Smart Ways To Teach Kids About Money From A Former Goldman Banker

Parents will recognize the following as the “If You Give a Pig a Pancake” problem, referencing the ubiquitous children’s book about giving a pig the first thing (a pancake) which leads to the next thing (some syrup), which leads to the next thing (a napkin), and so on.

For those of you who have not been parents in the past twenty years and aren’t familiar with the pig & pancake problem, file this one under the “Department of Unintended Consequences” Tab.

Fast forward a few weeks to a conversation she had with my Managing Editor (aka wife) last night.

“Mommy. I need money.”

“Why?”

“There’s a book fair at school but Daddy took all of my money and put it in stocks. And stocks are not fun at all.”

“I’m sorry dear.”

“Can I have an allowance?”

“Let me talk to Daddy.”

Ugh. It is true that I took all of her money. And converted it into shares of Kellogg stock.

And it’s also true that the steady stream of loose teeth – her main source of revenue via the Tooth Fairy – has dried up lately. There’s just no telling when the next tooth will drop, and then the school book fair comes up. Girls who don’t lose teeth don’t get paid. And then she needs fairy princess dolls, then it’s just all like, bills, bills, bills for my eight year old right now. You understand what I’m saying.

I didn’t hear about this conversation at first, but I noticed my oldest daughter kept prompting my wife to bring up some particular unnamed topic last night.

My daughter was eager for the conversation, but my wife strongly preferred that she and I develop a common strategy with regard to allowances, without having to simultaneously negotiate with an eight year-old.

(Here’s where I ought to insert some analogy between negotiating with 8 year-olds and negotiating with terrorists. Or lately, negotiating with Congressmen overly responsive to hard-core constituencies, encouraged by a system gerrymandered for incumbency. But I digress.)

Also, my wife assumed I’d have some strong ideas about what to do when it comes to kids’ finances. You probably won’t believe this, but I have a lot of thoughts about allowances.

Allowances!

So now we have moved, like the proverbial pig and his pancake, from the “first stock investment” phase to the “allowance phase” of parenthood. At this point my wife and I haven’t fully decided what to do, although I’m about to explain to you my best ideas so far, at least for the first month of her allowance.[1]

This is one of the cleverest allowance ideas I’ve ever come across, so I thought I’d share before even rolling it out to my family.

In fact he lists three great ways of teaching the power of compound interest to kids through the mechanism of the allowance. Each one has its own special advantage.

The power of compound interest – The Cookie Jar Experiments

Tobias describes three versions of what he calls the Cookie Jar Experiment, which over a month or two can viscerally and intuitively teach the magic of compound interest to kids through the mechanism of an allowance.

Version One. Offer your kid $1 on Day 1, and put it in a cookie jar.[2] Offer to add 10% more each day, as ‘daily interest growth’ on that original $1.

So, for example, on Day 2: $1.10 would be in the jar,

Day 3: $1.21. And then on

Day 4: $1.33.

After a month there will be a total of $17.45 in the jar, which shows how powerful 10% compounding can be, even if you begin with just $1.

Tobias suggests you probably won’t continue the experiment to the end of Month 3 ($5,313) or Month 6 ($28 million) but really that’s up to you and your own resources.

In my opinion, the power of compound interest as a concept is really worth teaching, so some of you will want to consider going the full 6 months. It will only cost you $28 million in total. If you do decide to do everything it takes to teach little Johnny the power of compound interest, be sure to email me at Bankers Anonymous so that I can provide my bank account number for the minimal 2% fee I normally charge for this kind of life-changing advice.

Anyway, back to my regularly scheduled commentary. While ‘real life’ doesn’t let you compound at 10% on a daily basis,[3] the experiment lets you demonstrate the amazing power of compound growth to your kids in a concrete way.

The 1 month time period – by which $1 grows to $17.45 – is short enough that kids can see the growth and just how powerful it can be.

Version Two.

This next version of the Cookie Jar Experiments is best for two kids, and it can drive home the power of compounding early, plus delayed gratification.[4]

Between your two kids, you offer a similar deal to version one, but with a twist. If one of them is willing to skip the first three days of interest accrual, they can get something desirable like a chocolate bar.

After they finish fighting over the chocolate, you run the experiment for, say, two months.[5] The child who went without the chocolate has $304, while the ‘lucky’ child who got the chocolate only has $228 in the cookie jar at the end of 60 days.

The lesson: Start saving early because it’s the earliest accruing period that matters the most.

The child with $304 can now buy a whole bunch of delicious cookies and leave the greedy chocolate eater weeping.

Run the same experiment as in Version One, but use the interest rate associated with many credit cards. Let’s pick 20% because it’s a round number, even though many people’s effective credit card rates are even higher.

Start adding money to the $1 at a 20% growth rate and label this ‘Credit Card’ growth. On Day 19 the ‘credit card’ account has grown to $32, versus the $6 to which the original savings at 10% per day grew.

If you run the comparison all the way to Day 35, the difference is $590 for the credit card account versus $28 for the ordinary 10% growth account. The key to this version is pointing out that some people scrimp and save and achieve some growth on their savings, while others pay huge portions of their money to credit card companies.

Again, of course, whether you fill up a cookie jar with $590 is up to you and your family’s means, but you can create an unforgettable demonstration for your kids of how small differences in compound interest rates make for giant differences in the medium and long run.

So what will we do about the allowance request?

So will we decide to run these experiments on our children when they request an allowance?

I’m going to push for at least Version One to kick off the new allowance phase for my eight year-old.

“One thing kids like is to be tricked. For instance, I was going to take my little nephew to Disneyland, but instead I drove him to an old burned-out warehouse. “Oh, no,” I said. “Disneyland burned down.” He cried and cried, but I think that deep down, he thought it was a pretty good joke. I started to drive over to the real Disneyland, but it was getting pretty late.” – Jack Handey

That’s why I say, deep down inside, she’s knows stock investing is fun. And so are Daddy’s experiments with allowances.

[1] After that, we may revert a more typical $2/week, conditional on a usually-left-undone chore – cleanup of the girls’ room – that drives my wife nearly to glue-huffing, out of frustration, on a weekly basis.